A global panic in 1997-98 was eventually quelled by systematically flooding the system with money. Yet, this time around, no one gave any credence to the idea that basically the same problem could be solved by far greater “quantitative easing.”

As for economists, the debate has been almost exclusively about whether the recession would end as a “U,” i.e. a long and drawn out recovery, or an “L,” no recovery for many years. The consensus scoffed at even the mere possibility of a “V,” that growth could revive even by late 2009.

As far as I’m concerned, it’s much too early to call this a V or even a U. In fact, we could well be facing an L, if there were another shock to the system. And I still believe a return by the S&P 500 to 600 or so is possible under the wrong conditions. But there are also definitely signs of improving conditions that, if they continue, could well mean a U or even a V.

Fortunately, the distinction is basically irrelevant to investing in Canadian trusts and high-yielding corporations. Basically, we’re buying businesses here. We know conditions are challenging now and could be for some time. But we also know prices are very low. And as first quarter earnings roll in, we’re learning that more than a few trusts and corporations north of the border are still posting some strong business numbers amid horrendous conditions.

As long as that’s the case, their dividends will be safe and ultimate share price recovery assured, no matter how long a recovery takes to unfold. Where the economic argument does matter, however, is with the timing.

Since March 9, we’ve seen a definite V for the S&P/Toronto Stock Exchange Income Trust Index, which is up nearly 40 percent in US dollar terms from then to now. Several Canadian Edge Portfolio trusts have nearly doubled.

It would be nice to say that the catalyst for the recovery was that investors are finally waking up to extreme values and returning high-quality companies to proper valuations. As much as I like my favorite trusts, however, the real force behind this upward explosion is the one driving almost all global markets higher: growing investor optimism that we’re headed for at the least a U-shaped global recovery in coming months–and possibly a V.

As I’ve been pointing out here, Canada is a country with strong fundamentals that have kept its fortunes generally stable throughout this crisis. Exhibit A is the graph “North American Malaise,” which compares Canada’s gross domestic product with that of the US.

Like the US, Canada’s economy shrank in late 2008 and early 2009. But the rate of decline throughout this recession has been far less there than here. Moreover, the most recent GDP figure reported by Statistics Canada–negative 0.1 percent for February–is barely a drop at all and a huge improvement from the prior period.

The main reason for Canada’s relative strength is it never indulged in the leverage excesses of American business, consumers and government. Its banks never abandoned conservative lending practices, partly because of tougher regulations but also because executives never pressured Ottawa to remove them. Capital ratios are several times those of US banks, and Canadian banks also have the wherewithal to invest abroad.

Remembering the economic slump of the 1990s, its companies never levered up either, preferring instead to maintain a conservative profile to guard against a rainy day. Its consumers never indulged in a borrow-and-spend frenzy. And even its government–despite funding a bevy of social services like universal health care–ran a surplus for years and even now is operating at a rough balance.

Canada also has another ace in the hole: a wealth of natural resources that now have support from another major market besides the US, namely China. Before this crisis hit, China was already consuming more than twice the amount of copper as the US, a 180-degree change from just five years ago. It, too, curtailed demand in late 2008, but there are now distinct signs the country is stockpiling again as it revs up for the next phase of its historic infrastructure building boom.

In the late 1990s, the US share of Canada’s exports was in the high 90 percent range. Now that figure has fallen toward 70 percent. The US is still by far the most important market for Canadian oil and other resources, but it’s no longer the only option by a long shot.

To be sure, the US is still the only game in town for much of the country’s heavy industry. Not only are automobile manufacturers intimately connected to Detroit, but so are myriad other businesses such as metals refiners, miners and shippers. Eastern Canadian industry has been hit heavily during this recession and won’t fully recover until Detroit does show some signs of life.

Manufacturers of construction materials and forestry companies are in the same boat with the US housing industry. The bankruptcy filing of AbitibiBowater (TSX: ABH, NYSE: ABTWQ) is directly related to collapsed demand for its bevy of timber products. And its demise has had a chain reaction as well, hurting paper and pulp companies as well as biomass power trusts such as Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF).

The good news, however, is we are starting to see some “green shoots” in Canada. That is, there are bits and pieces of good news that indicate the economy may indeed be improving. And if these green shoots continue to grow, we can look forward to a continuation of the rally that began March 9.

To be sure, the country is still historically cheap. The S&P/TSX Trust Index, for example, still trades more than 40 percent below the highs set last summer. The index dividend yield is well over 14 percent–even after the recent round of dividend cuts–and the average price-to-book value ratio is just 1.28.

Clearly, the expectations bar has been set very low here, relative to what’s prevailed in normal times. That leaves an awful lot of upside if economic conditions do improve.

Ultimately, how a Canadian trust or high-yielding corporation will fare depends on how well its business is run. That means investors are going to have to keep looking at the numbers to ensure holdings are still measuring up, as I’ve done this month in the Portfolio Article and will do in subsequent Flash Alerts this month.

The good news is, if we do our job the trusts and high-yielding corporations we own are going a lot higher in coming months. In other words, ensuring business quality–not guessing on market timing–is still the most important key to success in this market. That’s just as it’s always been. Being able to ensure portfolio quality, however, gets considerably easier if business conditions improve. And even the most patient investor needs to get paid sometime.

Healthy Signs

So how does Canada look now, and what are its prospects for recovery? A country’s GDP is basically a view from 30,000 feet on its economic health. From that vantage point, Canada has a ways to go before it can be considered a picture of health, after contracting for the seventh consecutive month in February.

Behind the numbers, however, there are some definite positive signs. For one thing, the rate of contraction in February was only 0.1 percent, or an annual rate of -1.2 percent. That’s basically a rounding error.

For another, the biggest factor behind that posted decline was a -2.1 percent drop in construction activity, largely because fewer new homes were built in February. That trend now appears to be reversing with a vengeance.

In March, following five straight months of decline, Canadian building permits rebounded 10 times faster than expected. The key was non-residential construction, which soared 48 percent led by an 89 percent boost in institutional buildings. But even residential permits rose a solid 5 percent, with single-family home construction permits ticking up 3.7 percent.

Overall building numbers remain well below those that prevailed just a few months ago. But they’re a far cry from the declines registered at the peak of the financial crisis, and they’re a very good sign for the country’s property and housing markets, which had been coming under some pressure.

Manufacturing was also a key point of weakness in the numbers. But activity in February advanced for the first time in seven months. The key was a revival in auto industry related sales, and that improving trend appears to be accelerating.

According to data for April, Canadian business spending grew “unexpectedly” for the first time in six months, as the country’s Purchasing Managers Index rose to 53.7 from a level of 43.2 in March. Index levels over 50 indicate economic expansion.

Of course, Canada’s most important industry by far is energy and here the prognosis has been grim. Not only have falling energy prices slashed into producers’ profits, but they’ve also slowed drilling dramatically. That’s the clear message in drillers’ first quarter earnings, mainly a steep increase in idled rigs. And every industry connected with energy has suffered as well, including real estate investment trusts operating in the energy patch.

Here too, however, we may be on the cusp of a turn. For one thing, China has become a much more important market for Canadian oil and its economy is showing signs of accelerating again. China’s first quarter GDP growth was just 6.1 percent, the slowest rate in nearly a decade as exports slowed. But there’s also building evidence that the government’s stimulus package is starting to pump things up again, for example accelerating growth for both industrial output and fixed asset investment in March.

There are still plenty of reasons to be skeptical about China, particularly with the rest of the world weakened as an export market. But with its inflation problem at least temporarily licked, the country is certainly free to stimulate its domestic market, and that means more demand for Canada’s commodities. Canada is also pursuing an expanded economic relationship with Europe as a counter to over dependence on the US, though this will likely take time to unfold.

Ultimately, the recovery of Canada’s energy patch depends on one thing: higher oil and gas prices, spurred by global economic recovery and the unprecedented supply destruction since last summer’s peak.

Last summer’s move of oil toward USD150 and gas into the low teens was spurred by concerns the world could not produce enough oil to meet demand. Thanks to demand destruction, the supply levels the industry expected are no longer possible in the same time frame. The result will be even greater price spikes than last summer’s, once the global economy does recover.

Because higher energy prices depend on global demand and therefore the world economy, the timing of an energy patch recovery is largely out of the hands of Canada. Oil prices have surged dramatically since hitting what now appears to be a triple bottom around USD30 a barrel in early February. Natural gas, on the other hand, is still scraping along under USD4 per million British thermal units. That’s more than a third below where it began 2009 and 75 percent off last summer’s highs.

When it comes to the Canadian economy, oil is probably the more important commodity. That’s in part because the oil sands represent the biggest upside for production going forward, though a price for oil of USD70 a barrel is probably a minimum level for many projects.

But when it comes to individual trusts, low natural gas prices are the single biggest thing holding back earnings. And a gas price recovery depends far more on the North American economy, particularly industrial demand.

Overall, the relationship between Canada and energy prices is something of a chicken-and-egg story. It’s hard to imagine the country bouncing back fully unless energy prices do, yet the North American economy must recover for energy prices–particularly natural gas–to do so.

My view is eventually we’ll see the resumption of the same virtuous cycle that helped Canada earlier in the decade, where rising energy prices helped the economy. But oil is unlikely to lead things higher on its own. We’re going to have to be patient.

A final barometer is the Canadian dollar itself. Alarmed at the steep appreciation of the currency this decade, the Bank of Canada (BoC) began trying to manage the loonie lower in late 2007. The BoC’s efforts succeeded in bringing it back below parity with the US dollar into the 90 cent range. Then came the financial crisis and flight to the US dollar, driving the exchange value to less than 77 US cents.

At its core, the Canadian dollar is a petro currency, whose fortunes rise and fall with commodity prices. Rising demand and prices for Canada’s commodity exports increase demand for Canadian dollars and investments, driving up the loonie’s value. Falling demand and prices hit the loonie’s exchange value.

When the Canadian dollar was scraping lows in the 1990s against the US dollar, its economy was in tatters due to a multi-year bear market in resources. Similarly, the massive decline last year was, more than anything else, a reflection of sharply lower energy prices.

Since the low on March 9, however, the loonie has bounced back to the mid-80s, a level not seen since last fall.

A rising loonie pushes up the US dollar value of shares of Canadian trusts and high-yielding corporations, as well as their distributions. The chief negative is it hurts businesses of companies that compete with US rivals.

But a rising currency is a very good sign that the health of the overall Canadian economy has improved markedly since last fall, and that this isn’t the 1990s. That’s a good sign for all investments Canadian.

Sector Selector

In the March 2009 Feature Article, I examined the prospects of the major sectors tracked in the How They Rate universe, and what that outlook means for individual trusts and high-yielding corporations. Here’s how I see it now, from least to most economically sensitive. For buy targets on individual trusts and corporations, see the How They Rate Table.

Electric Power. Carbon neutral is set to be the key advantage for generating electricity in North America over the next several years, as new regulation on CO₂ kick in. That’s a big advantage for the power trusts in the Canadian Edge universe, most of which rely on a combination of hydro, wind and biomass for generation.

Power trusts generally enjoy long-term contracts with the most creditworthy buyers (government entities and regulated utilities) that allow them to sell as much energy as they can at escalating prices, as well as automatic cost recovery. As a result, their distributions have proven to be highly recession resistant.

The only exception has been Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF), whose wood waste supplies have been interrupted by the collapse of the Canadian forestry industry, forcing the shutdown of its biomass power facilities.

On the other end of the spectrum are Great Lakes Hydro Income Fund (TSX: GLH-U, OTC: GLHIF) and Innergex Power Income Fund (TSX: IEF-U, OTC: INGRF), which produce solely from hydro and wind. Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF) and Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF) rely heavily on natural gas cogeneration, which also has a big CO₂ advantage.

I use power trusts as safe income streams and they haven’t let me down. Historically, they’ve been vulnerable to an uptick in inflation. But after the recent market meltdown, the spread between their yields and benchmark government bonds is near all-time highs. The potential for that gap to narrow sharply limits the risk to a rise in interest rates, as does the fact that they’re priced in a currency that provides a natural hedge against inflation–the Canadian dollar.

Energy Infrastructure. Owners and operators of fee-based pipelines and energy storage and processing facilities are for all practical purposes as recession-resistant as electric power generators. Customers are generally the largest and most creditworthy energy companies. Contracts are long-term and generally not exposed to changes in commodity prices. And many are based on capacity, so owners get their fees even if no energy is shipped or processed.

The model for growth is basically to buy and build assets, adding them to rate base. In my opinion, it will work as long as infrastructure owners continue to contract them out before starting work, definitely the case today.

My top selections remain AltaGas Income Fund (TSX: ALA-U, OTC: ATGFF), Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF) and Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF). All will continue to pay their distributions as long as the downturn lasts. And all are well-positioned to take advantage as the global economy revives and Canada’s energy industry revs up again.

Health Care. Contrary to popular belief, there’s plenty of opportunity for well-run companies and trusts to make money in Canada’s health care system. In fact, given the government commitment to funding the system, business is actually even steadier than in the US, making healthcare one of the most reliable sectors.

My favorite here is CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF), which provides testing services and recently made a foray into the US where it promises to be a big winner from President Obama’s health care policies.

I’m generally bullish on the other How They Rate representatives, with the exception of Extendicare (TSX: EXE-U, OTC: EXMUF), which is actually more of a REIT and has had a difficult time generating reliable revenue.

Information Technology. Like its US counterpart, the Canadian communications industry is proving recession-resistant, as the desire for enhanced connectivity continues to trump the need to tighten belts. Safest are service providers.

My favorite remains Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF), which had another very strong first quarter and enjoys a de facto monopoly throughout most of its territory. It also pays a higher yield than every other How They Rate sector entry, with the exception of my other favorite, Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF).

The print/Internet directory company continues to be unfairly lumped in with much less adept, now failed US directory providers but continues to produce strong numbers quarter after quarter. Overall, this is a very safe and reliable group for income and growth and should be for many years to come.

Gas/Propane. These not-quite-utility companies and trusts are a decidedly mixed bag in terms of risk now. All of their businesses are generally recession-resistant, from the water heater rentals of Consumers Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) to the ice sales of Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF). Some, like Arctic, have run afoul of regulation and are paying the price. The key here is to stick with trusts and companies that are holding up as businesses and avoid anything else.

My current favorite is Energy Savings Income Fund (TSX: SIF-U, OTC: ESIUF), which continues to expand its reach with acquisitions and well as snare new customers in both the US and Canada. The only one I’d avoid now is Arctic, at least until there’s some light at the end of the tunnel for the wave of lawsuits against it.

Financial Services. Canada’s banks have held up better than financial institutions anywhere in the world during this crisis. That’s been a big plus for companies and trusts, which need access to credit. Investing in the sector, however, is also a decidedly mixed bag.

I’ve stubbed my toe with GMP Capital Trust (TSX: GMP-U, OTC: GMCPF), which is converting to a corporation early and has suffered from the Toronto market’s weakness. I now prefer investment company Brookfield Asset Management (TSX: BAM/A, NYSE: BAM) and Bank of Nova Scotia (TSX: BNS, NYSE: BNS).

I’m currently not holding any sector representatives in the Portfolio, though I may add one if business fundamentals continue to improve in coming months.

Food & Hospitality. I just added my first sector trust to the Portfolio this month, Colabor Income Fund (TSX: CLB-U, OTC: COLAF). This is another group where the potential selections vary widely in terms of risk and reward.

Colabor is attractive for its high yield and very steady business, as well as the fact that it’s effectively already dealt with its 2011 issues by already starting to pay trust taxes.

I’m generally cautious of most restaurant royalty trusts, mainly because of their uncertain post-2011 tax status for US investors, but also because franchises can be so fleeting. That said, the best of that bunch appears to be A&W Revenue Royalties Income Fund (TSX: AW-UN, OTC: AWRRF), which had another bang-up quarter despite deteriorating market conditions.

Real Estate Trusts. I’ve focused the Portfolio on three of the very safest of this sector: Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), Northern Property REIT (TSX: NPR-U, OTC: NPRUF) and RioCan REIT (TSX: REI-U, OTC: RIOCF). All three have proven to be extremely recession-resistant in the past and are doing so again this time around. They’re also super yield payers and have demonstrated their ability to grow. We don’t have much to worry about any of them, and they remain portfolio bedrock. All will also avoid additional taxation in 2011.

The REIT sector, however, also has its share of high-octane selections, a legacy of earlier in the decade when the Canadian property market was literally on fire and initial public offerings were coming fast and loose.

My selection from that group has been Artis REIT (TSX: AX-U, ARESF), which has participated heavily in the energy patch economy. That’s a market that appears to be weakening. But the REIT is well shielded nonetheless by below-market contracts.

Unfortunately, the same can’t be said of many of the other REITs, and if conditions should get bad enough, there could be more dividend cuts such as we’ve seen in recent months. In short, my strongest advice is to stick with the best and avoid the rest.

Business Trusts. Some businesses are more recession-resistant than others is the watchword for this group. I like several of these, particularly Portfolio pick Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF), which has proven to be a big winner for us.

I also like converted trust BFI Canada (TSX: BFC, OTC: BFCUF), which as a hauler of waste is in one of the most recession-resistant businesses imaginable, and Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF), whose theater business is defying conventional wisdom by thriving.

On the other side, however, is a handful of trusts and companies that have completely cracked during the bear market recession and now trade at or below USD1, some paying no dividend. There’s no reason whatsoever to own these. They’ve cut their dividends for a reason that’s more than likely still a major thorn in their sides.

Transports. Some of the trusts and companies in this sector have been extremely hard hit by the recession, evidenced by the large number of sells and representatives on the Dividend Watch List. Unfortunately, these conditions aren’t going to improve until the North American economy revives. And some, like Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF), may lag even then, as they’re vulnerable to another spike in fuel costs. I continue to like three members of the group, however.

Portfolio pick TransForce (TSX: TFI, OTC: TFIFF) has taken some hits from the downturn, as traffic has dropped. But management remains focused on its goal of consolidating the transport industry, and it will rebound sharply in an upturn. Note the company has already converted to a corporation, so there’s no 2011 risk.

The other two are basically bus makers New Flyer Industries (TSX: NFI-U, OTC: NFYIF) and Student Transportation (TSX: STB-U, OTC: SUDRF), which continue to enjoy a stream of orders from fuel conscious governments in the US, now flush with stimulus money. Note that neither has 2011 exposure, as they, like Portfolio holding Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF), are organized as income participating securities, combining debt with ordinary equity to produce a high yield.

Oil and Gas. The best thing this sector has going for it is very low valuations. Producers aren’t as cheap as they were in March or even last month. But most still trade at deep discounts to their net asset value, or the value of their reserves in the ground less any debt attached to them.

The biggest vulnerability of most trusts is low natural gas prices, which are now hovering right around cash costs of many producers. This makes the fuel not only uneconomic to develop for new reserves but also to produce. At this point, there’s a glut of natural gas inventories in North America, and sentiment is phenomenally bearish. That plus the massive demand destruction we’re seeing is pretty good reason to believe prices are ripe for a rebound.

But trusts heavily dependent on natural gas should be considered at risk for distribution cuts in the near term. That includes several of my favorites, including Daylight Resources Trust (TSX: DAY-U, OTC: DAYYF).

In contrast, the least vulnerable are trusts that rely on oil and global markets for gas sales. Not surprisingly, the prime example is Vermilion Energy Trust (TSX: VET-U, OTC: VETMF), still the best choice for conservative investors in the sector and the only sector trust that’s affirmed its intention to pay its current distribution rate after 2011.

Note that I intend to stick with all of the energy trusts in the Portfolio as a bet on the eventual recovery of energy prices. The only exception is Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV), which I’m selling this month because its planned conversion to a corporation is a taxable event for US investors and because it no longer pays a dividend.

Natural Resources. This sector includes companies whose fortunes depend on the price of other commodities besides energy. Some are miners. Others are metals refiners, forestry companies, pulp processors, chemical companies and even equipment makers.

Most do considerable business in the US, and many are intimately connected with US industries like steel, automobiles and housing. As a result, it’s no great surprise that this sector has been among the very worst performers over the past year and that there have been nearly as many dividend cuts as with oil and gas producers, even though the group is much smaller.

Once the US economy shows real signs of recovery, it’s going to be off to the races for this leveraged group. Until then, however, it’s going to be very tough sailing for most. As a result, I’ve kept the exposure of the CE Portfolio to two selections: Ag Growth Income Fund (TSX: AFN-U, OTC: AGGRF) and Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF). Both occupy well defined niches, i.e. corn equipment handling and sulphuric acid in Latin America, respectively. And both also have little 2011 risk, as Ag has announced its conversion to a corporation without cutting its distribution and Chemtrade has affirmed its intention to keep paying at the same rate indefinitely, either as a corporation or a trust.

I continue to watch both trusts carefully for signs of weakness, however. In general, I advise avoiding any trust that depends heavily on US demand.

Energy Services. If any sector is more leveraged to energy prices than are energy producers, this is it. Higher energy prices boost earnings by increasing utilization of their rigs and services, and allow fee increases for their use. Lower energy prices slash demand for rigs and services, as well as prices.

Canada’s energy services sector has effectively been on the ropes since late 2006, when natural gas prices began to fall in earnest. It enjoyed a brief surge in early 2008, as energy prices surged, but has since crashed and burned in the wake of falling oil and gas prices.

All but Phoenix Technology Income Fund (TSX: PHX-U, OTC: PHXIF) have cut their distributions at least once over the past couple years. Nonetheless, this is one group where at least aggressive investors need some exposure.

For one thing, the companies and trusts are cheap. For another, there’s no group that will do better when energy prices return to the upside, and in fact several have already rebounded nicely.

The two Portfolio selections are trusts that have already converted to corporations to shelter capital in this tough market: Newalta Corp (TSX: NAL, OTC: NWLTF) and Trinidad Drilling (TSX: TDG, OTC: TDGCF). Both have continued to grow despite the immense challenges they face and their balance sheets remain well-suited to survive the challenges ahead.

Otherwise, I like Phoenix as a specialist in horizontal drilling and Precision Drilling (TSX: PD-U, NYSE: PDS) as a large player and potential Canadian national champion, though it pays no dividend at present. Precision last month received a major cash infusion from an affiliate of the Alberta government, even as it reported solid first quarter earnings.

Tread with care, but this could well be the best-performing sector over the next year–if indeed we have seen our first green shoots for a Canadian economic recovery.